Business structures: Limited Liability Partnerships

A limited liability partnership is a relatively new type of business structure, created by the Limited Liability Partnerships Act 2000. It shares qualities with both companies and with traditional partnership structures.

By and large, partnership law does not apply to an LLP, but the arrangements between the partners may closely follow a traditional partnership agreement.

Body corporate

An LLP is legal entity and a body corporate. That means it has a legal personality separate from that of its members (owners).

Where a business is a traditional partnership, a third party enters into a contract with one of the partners. With an LLP, the contract is between the third party and the LLP as an entity. The effect is that the LLP is responsible for the fulfilment of a contract, not individual members.

That feature is shared with limited companies.

Limitation of partner liability

As the name suggests, the liability of members of an LLP is limited. In a partnership, the liability of the partners is unlimited. If a partner is negligent in work done for a client, there would generally be two possible causes of action against that partner: contract and tort. If the same work is contracted to a limited liability partnership, then on the face of it, no liability can falls to the member who was negligent.

Partners or employees?

Despite the similarity with a limited company, the members in a limited liability partnership are not employees of the partnership, whereas the directors of a limited company are employees of the company.

Some partners of an LLP might not be members, but instead would be employees. In this case “partner” would be a job title designating senior employment status, rather than membership. This is often the case in professional service firms where there are both salaried partners (employees entitled to a share of the profit of the firm as a bonus through their employment contract) and equity partners (who are members who share in both the profit and losses of the partnership).

Companies as members

There is nothing in the LLP Act to prevent a limited company being a member. This opens up interesting possibilities for joint ventures and profit sharing. For example, in the claw back of tax losses, the partnership agreement could specify that the corporate partner should take the first share of profit, and a second partner the remainder. Similarly, in a property venture, the partners could allocate profit according to conditions and degrees of success.

Forming a limited liability partnership

There are precise provisions for registration of an LLP, which are not dissimilar for those for creating a new limited company. However, you cannot buy an "off the shelf" limited liability partnership. The original documents have to be prepared with the names of the first set of members.

At least two people "carrying on a lawful business with a view to profit" must subscribe their names to a document called an "incorporation document".

The incorporation document must be delivered to the Registrar of Companies at Companies House.

A statement must also be delivered to the Registrar that there has been compliance with the requirement that at least two persons, associated for the purpose of carrying on a lawful business with a view to profit, have subscribed their names to the incorporation document.

The statement must be made by a subscriber to the incorporation document or a solicitor engaged in the formation of the LLP.

The incorporation document must include this information:

the name of the business

whether the registered office is to be situated in England and Wales, (in Wales or in Scotland, the address of the registered office)

the name and address of the persons who are to be members on incorporation

whether some or all of the members are to be designated members

Partnership agreement

Partners in an LLP are not obliged to enter into a formal partnership agreement. In practice, however, they will almost certainly get together to decide on the structure and regulation of all aspects of their business, in just the same way as prospective partners in a traditional partnership.

The agreement they make is binding on them after the LLP has been registered.

The agreement itself is not registerable and so remains confidential.

If there is no agreement, or the agreement is silent on an important point, then formal default provisions apply in much the same way as the application of the default provisions of the Partnership Act 1890. The default provisions of the Act are simple and straightforward.

Partner money subscribed

The Act states that the amount subscribed by a member is the amount of his contribution to the capital, less money:

he has previously drawn out or taken back

he draws out or receives back during a period of five years from the relevant date

he is entitled to draw but does not draw

he is entitled to seek from another partner

Partner liability on insolvency or winding up

The amount of his liability on a winding up is effectively the amount set out in the limited liability partnership agreement. In most cases the greater amount referred to of these two alternatives will be the first set, namely the amount the partner has put in, together with the net amount he has drawn for the last five years.

Designated members

A designated member is either an original member, or someone who is notified to the registrar as being a designated member subsequently. There must be at least two at any time.

The designated partners are liable for the correct filing and recording of the partnership affairs. It is they too, who will be subject to the criminal penalties of failure to comply.

The LLP may give notice to the registrar that every partner, and future partner is, or shall be a designated member. This saves notifying the registrar of the change when a designated partner leaves or joins the partnership.

A person ceases to be a designated member as soon as he stops being a partner.

In small partnerships, it is likely that all partners will be designated partners.

The partnership must notify the registrar:

of the appointment or retirement of a member or designated member within fourteen days

of a change in the name or address of a member, within twenty eight days

Failure to comply with the filing provision carries liability to a fine of up to £5,000.

Transactions with third parties

The law of ostensible authority applies to partner transactions. Every partner is an agent of the limited liability partnership. The LLP is bound by every contract made by any partner, unless the partner had no authority to make the contract and the third party was aware of that fact.

The limited liability partnership remains bound by contracts made by former partners, unless the other party has been told that the former partner is no longer a member, or the registrar has received a notice to that effect.

Tax

Much of the Act is taken with amendments to the Income and Corporation Taxes Act 1988.

The profits of the business are taxed as if it were carried on by partners in partnership, rather than by a body corporate. This ensures that the commercial choice between using a limited liability partnership or a standard partnership is a tax neutral one.

There are fair and foreseeable provisions to restrict set off of losses elsewhere against partnership profits of a partner and other anti-avoidance measures.

The members are charged capital gains tax in largely the same way as traditional partners in a partnership. Neither the commencement of the LLP, nor any change of partner is treated as an event giving rise to a charge to CGT.

The Inheritance Tax Act 1984 has been amended to provide that the partners and partnership assets of a LLP are treated in largely the same way as those of a traditional partnership.

Subject to certain rather complicated exceptions, stamp duty is not chargeable on a transfer of property of any sort into or out of the partnership, provided the transfer does not have the effect of changing the entitlement to the value of that property of the person transferring it.

In other words, you can transfer your property to the partnership without stamp duty penalty provided your partnership agreement still entitles you to the value of it or you receive cash to that value.

Businesses transferring into an LLP structure

The transfer of an existing partnership business to a limited liability partnership will not be treated for tax purposes as a cessation of the original, unless in identical circumstances a transfer between one partnership and another would qualify.

When to use a limited liability partnership

Generally, the essence of a limited liability partnership for practical purposes is as a vehicle to contain a partnership of any size where partners may be at risk from the careless or accidental negligence of a colleague.

For example, partners in an accountancy firm would be protected from personal liability if a claim was successfully pursued by a major client; and partners in a construction business would be protected if a new building collapsed.

An LLP may also be appropriate for a partnership where some partners are not actively involved, but rather are just lenders to the business. They might have once been called sleeping partners. This will suit both a company and an individual lender.

The LLP structure is also more suitable for a group of people engaging together in a property or finance venture where it may be necessary to account for partners coming and going more frequently than you would expect in a normal partnership business.

The structure is unlikely to replace any small trading company because a conventional limited company is likely to perform an appropriate role at less administrative cost.

The main benefits of an LLP against a limited company are:

less public scrutiny because the partnership agreement remains confidential

easier changes of ownership shares between partners

Weighing against that is that there is a lack of a body of law to protect minority members.

Document templates

Net Lawman provides two template LLP agreements, where one provides for all the partners being active in the business, and the other for where some partners are simply sleeping investors.

Please note that the information provided on this page:

Does not provide a complete or authoritative statement of the law;

Does not constitute legal advice by Net Lawman;

Does not create a contractual relationship;

Does not form part of any other advice, whether paid or free.

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